Warren Buffett Strategy: How to Get ‘Buffett Yield’

Warren Buffett strategy: If his recent impersonation of Breaking Bad’s Heisenberg has shown us anything, it is now clearer than ever that Warren Buffett is one tough dude. He’s one of the most widely emulated investors in the financial world, and aside from maybe the President and the acting Fed chairman, Buffett’s words have historically moved markets like only a few others can.

In the media, the billionaire’s stock picks are scrutinized endlessly, and with a portfolio of nearly $90 billion invested in U.S. equities, this over-analysis is usually for the better. In fact, we discussed the market-beating potential of Buffett’s small-cap gems here on MarketWatch last week, though we think one group of investors might have felt left out.

hedge funds vs. mutual funds

We’re talking to you, dividend investors. Warren Buffett has plenty of holdings that pay consistent income to their shareholders, and there are a few that stand above the rest for two reasons: (1) they sport payout ratios below industry norms, and (2) dividend payments have at least doubled in the past five years. Let’s see how you can get what we like to call “Buffett yield,” i.e. dividend yield with strong potential to expand in the future.

Wells Fargo

The largest holding in Buffett and Berkshire’s equity portfolio that fits both criteria is coincidentally his biggest bet overall: Wells Fargo & Co (NYSE:WFC). The banking giant overtook The Coca-Cola Company (NYSE:KO) for his No. 1 spot in the fourth quarter of last year. It now represents a $19.1 billion investment for Buffett, good for 8.7% of Wells Fargo’s outstanding shares.

The bank offers investors a dividend yield of just below 3%, nearly three times what it paid in the first quarter of 2012. A payout ratio of 26% indicates that Wells Fargo has more room to increase dividends in the future, and the banking industry’s average is nearly five percentage points higher. Operating cash grew by 330% last year, with cash from financing registering a similar growth, and price-to-cash per share data indicates that Wells Fargo trades at an extreme discount—about one-third below its historical five year average.

U.S. Bancorp

Another holding to keep an eye on is U.S. Bancorp (NYSE:USB). The regional bank represents a smaller position than more publicized Buffett picks like American Express Company (NYSE:AXP) or Coca-Cola, but like Wells Fargo, it offers the attractive combination of a low payout ratio with extreme dividend growth. Generally speaking, payout ratio percentages in the retail banking space sit in the mid-30s, and U.S. Bancorp pays about 28% of its earnings out as dividends. The bank’s quarterly dividend has grown from 5 cents per share in 2010 to 23 cents per share this quarter and it currently yields 2.5%.

Card services

Buffett holds moderately sized positions in card services giants Visa Inc (NYSE:V) and Mastercard Inc (NYSE:MA), and both pay roughly half the level of earnings-to-dividends as industry norms dictate they should. Mastercard has doubled its quarterly dividend in the past year alone while Visa isn’t too far behind. Both still offer yields below 1%, but it’s reasonable to expect that more growth is on the horizon for income-seeking investors. We’ll be watching Buffett’s stakes in these two companies very closely moving forward.

The best of the rest

Out of the 42 stocks held in Buffett and Berkshire’s equity portfolio, just three more make the cut: Moody's Corporation (NYSE:MCO), National-Oilwell Varco, Inc. (NYSE:NOV) and Viacom, Inc. (NASDAQ:VIAB). By now, you probably understand they each offers a below-average payout ratio with exceptional dividend growth, so we won’t rehash that information again. It is worth noting that this trio lies outside of Buffett’s 30 largest holdings, and you should also know that of the three, Viacom offers the highest yield of almost 1.5%. The differential in yield between each is within 15 basis points, though, so it’d be rational to consider all three.

So there you have it: seven names and one-sixth of Warren Buffett’s equity portfolio that deserves the most attention from dividend investors. Check back here for more updates on Buffett strategy.

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Insider Monkey's small-cap strategy returned 47.6% in its first year ended last month, beating the S&P 500 index by more than 29 percentage points. Try it now by clicking the link above.

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